Allowance for Noncovered Loan and Lease Losses and Unfunded Commitments and Letters of Credit

We maintain an allowance for loan and lease losses (“ALLL”) to absorb losses inherent in the loan portfolio. The size of the ALLL is determined through quarterly assessments of the probable estimated losses in the loan portfolio. Our methodology for making such assessments and determining the adequacy of the ALLL includes the following key elements:


1.	General valuation allowance consistent with the Contingencies topic of the FASB ASC.


2.	Classified loss reserves on specific relationships. Specific allowances for identified problem loans are determined in accordance with the Receivables topic of the FASB ASC.


3.	The unallocated allowance provides for other factors inherent in our loan portfolio that may not have been contemplated in the general and specific components of the allowance. This unallocated amount generally comprises less than 5% of the allowance. The unallocated amount is reviewed quarterly based on trends in credit losses, the results of credit reviews and overall economic trends.

The general valuation allowance is systematically calculated quarterly using quantitative and qualitative information about specific loan classes. The minimum required level an entity develops a methodology to determine its allowance for loan and lease losses is by general categories of loans, such as commercial business, real estate, and consumer. However, the Company’s methodology in determining its allowance for loan and lease losses is prepared in a more detailed manner at the loan class level, utilizing specific categories such as commercial business secured, commercial business unsecured, real estate commercial land, and real estate income property multifamily. The quantitative information uses historical losses from a specific loan class and incorporates the loan’s risk rating migration from origination to the point of loss.

A loan’s risk rating is primarily determined based upon the borrower’s ability to fulfill its debt obligation from a cash flow perspective. In the event there is financial deterioration of the borrower, the borrower’s other sources of income or repayment are also considered, including recent appraisal values for collateral dependent loans. The qualitative information takes into account general economic and business conditions affecting our market place, seasoning of the loan portfolio, duration of the business cycle, etc. to ensure our methodologies reflect the current economic environment and other factors as using historical loss information exclusively may not give an accurate estimate of inherent losses within the Company’s loan portfolio.

When a loan is deemed to be impaired, the Company has to determine if a specific valuation allowance is required for that loan. The specific valuation allowance is a reserve, calculated at the individual loan level, for each loan determined to be both, impaired and containing a value less than its recorded investment. The Company measures the impairment based on the discounted expected future cash flows, observable market price, or the fair value of the collateral less selling costs if the loan is collateral dependent or if foreclosure is probable. The specific reserve for each loan is equal to the difference between the recorded investment in the loan and its determined impairment value.

The ALLL is increased by provisions for loan and lease losses (“provision”) charged to expense, and is reduced by loans charged off, net of recoveries. While the Company’s management believes the best information available is used to determine the ALLL, changes in market conditions could result in adjustments to the ALLL, affecting net income, if circumstances differ from the assumptions used in determining the ALLL.

We have used the same methodology for ALLL calculations during 2011, 2010 and 2009. Adjustments to the percentages of the ALLL allocated to loan categories are made based on trends with respect to delinquencies and problem loans within each class of loans. The Company reviews the ALLL quantitative and qualitative methodology on a quarterly basis and makes adjustments when appropriate. The Company continues to strive towards maintaining a conservative approach to credit quality and will continue to prudently adjust our ALLL as necessary in order to maintain adequate reserves. The Company carefully monitors the loan portfolio and continues to emphasize the importance of credit quality while continuously strengthening loan monitoring systems and controls.

The following table shows a detailed analysis of the allowance for loan and lease losses for noncovered loans for the years ended December 31, 2011 and 2010:



	Beginning Balance		Charge-offs			Recoveries		Provision (Recovery)			Ending Balance		Specific Reserve		General Allocation
Year ended December 31, 2011	(in thousands)
Commercial business:
Secured	$	21,811	$	(7,270	)	$	1,154	$	9,050		$	24,745	$	954	$	23,791
Unsecured	738		(639		)	1,444		(854		)	689		97		592
Real estate:
One-to-four family residential	1,100		(717		)	80		191			654		96		558
Commercial and multifamily residential:
Commercial land	634		(660		)	12		502			488		—		488
Income property multifamily	15,210		(1,407		)	414		(4,666		)	9,551		63		9,488
Owner occupied	9,692		(1,620		)	33		1,501			9,606		185		9,421
Real estate construction:
One-to-four family residential:
Land and acquisition	3,769		(1,419		)	1,978		(1,997		)	2,331		—		2,331
Residential construction	2,292		(1,068		)	113		(473		)	864		59		805
Commercial and multifamily residential:
Income property multifamily	274		(2,213		)	—		2,604			665		—		665
Owner occupied	70		—			—		(35		)	35		—		35
Consumer	2,120		(3,918		)	351		4,166			2,719		30		2,689
Unallocated	3,283		—			—		(2,589		)	694		—		694
Total	$	60,993	$	(20,931	)	$	5,579	$	7,400		$	53,041	$	1,484	$	51,557



	Beginning Balance		Charge-offs			Recoveries		Provision		Ending Balance		Specific Reserve		General Allocation
Year ended December 31, 2010	(in thousands)
Commercial business:
Secured	$	20,409	$	(12,779	)	$	1,218	$	12,963	$	21,811	$	600	$	21,211
Unsecured	1,560		(2,100		)	1,171		107		738		75		663
Real estate:
One-to-four family residential	1,072		(406		)	15		419		1,100		—		1,100
Commercial and multifamily residential:
Commercial land	664		(2,165		)	—		2,135		634		—		634
Income property multifamily	9,860		(1,969		)	124		7,195		15,210		59		15,151
Owner occupied	6,690		(2,039		)	2		5,039		9,692		—		9,692
Real estate construction:
One-to-four family residential:
Land and acquisition	5,711		(8,409		)	1,199		5,268		3,769		3		3,766
Residential construction	2,304		(2,447		)	474		1,961		2,292		62		2,230
Commercial and multifamily residential:
Income property multifamily	2,453		(3,107		)	775		153		274		175		99
Owner occupied	36		—			—		34		70		—		70
Consumer	1,282		(3,982		)	649		4,171		2,120		—		2,120
Unallocated	1,437		—			—		1,846		3,283		—		3,283
Total	$	53,478	$	(39,403	)	$	5,627	$	41,291	$	60,993	$	974	$	60,019

The 2009 changes in the ALLL for noncovered loans are summarized as follows:



	Years Ended December 31,
	2009
	(in thousands)
Balance at beginning of year	$	42,747
Loans charged off	(54,521		)
Recoveries	1,752
Net chargeoffs	(52,769		)
Provision charged to expense	63,500
Balance at end of year	$	53,478

Changes in the allowance for unfunded commitments and letters of credit are summarized as follows:



	Years Ended December 31,
	2011		2010		2009
	(in thousands)
Beginning balance	$	1,165	$	775	$	500
Net changes in the allowance for unfunded commitments and letters of credit	370		390		275
Ending balance	$	1,535	$	1,165	$	775

Risk Elements

The extension of credit in the form of loans to individuals and businesses is one of our principal commerce activities. Our policies and applicable laws and regulations require risk analysis as well as ongoing portfolio and credit management. We manage our credit risk through lending limit constraints, credit review, approval policies and extensive, ongoing internal monitoring. We also manage credit risk through diversification of the loan portfolio by type of loan, type of industry, type of borrower and by limiting the aggregation of debt to a single borrower.

The monitoring process for the loan portfolio includes periodic reviews of individual loans with risk ratings assigned to each loan. Based on the analysis, loans are given a risk rating of 1-10 based on the following criteria:


•	ratings of 1-3 indicate minimal to low credit risk,


•	ratings of 4-5 indicate an average credit risk with adequate repayment capacity when prolonged periods of adversity do not exist,


•	rating of 6 indicates higher than average risk requiring greater than routine attention by bank personnel due to conditions affecting the borrower, the borrower's industry or economic environment,


•	rating of 7 indicates potential weaknesses that, if left uncorrected, may result in deterioration of the repayment prospects for the asset or in the Company's credit position at some future date,


•	rating of 8 indicates a loss is possible if loan weaknesses are not corrected,


•	rating of 9 indicates loss is highly probable; however, the amount of loss has not yet been determined,


•	and a rating of 10 indicates the loan is uncollectable, and when identified is charged-off.

Loans with a risk rating of 1-6 are considered Pass loans and loans with risk ratings of 7, 8, 9 and 10 are considered Special Mention, Substandard, Doubtful and Loss, respectively. Loans with a risk rating of Substandard or worse are reported as classified loans in our allowance for loan and lease losses analysis. We review these loans to assess the ability of our borrowers to service all interest and principal obligations and, as a result, the risk rating may be adjusted accordingly. Risk ratings are reviewed and updated whenever appropriate, with more periodic reviews as the risk and dollar value of loss on the loan increases. In the event full collection of principal and interest is not reasonably assured, the loan is appropriately downgraded and, if warranted, placed on non-accrual status even though the loan may be current as to principal and interest payments. Additionally, we assess whether an impairment of a loan warrants specific reserves or a write-down of the loan.

The following is an analysis of the credit quality of our noncovered loan portfolio as of December 31, 2011 and 2010:



	December 31, 2011			December 31, 2010
	Weighted- Average Risk Rating	Recorded Investment Noncovered Loans		Weighted- Average Risk Rating	Recorded Investment Noncovered Loans
	(dollars in thousands)
Commercial business:
Secured	4.89	$	981,417	4.96	$	757,372
Unsecured	4.25	47,406		4.23	41,175
Real estate:
One-to-four family residential	4.81	64,063		4.96	49,436
Commercial and multifamily residential:
Commercial land	5.22	50,681		5.75	24,956
Income property multifamily	4.94	533,993		5.07	406,711
Owner occupied	5.05	404,789		5.12	366,284
Real estate construction:
One-to-four family residential:
Land and acquisition	6.43	25,201		6.79	37,054
Residential construction	5.94	23,931		6.63	31,293
Commercial and multifamily residential:
Income property multifamily	5.49	20,877		6.38	18,296
Owner occupied	4.55	12,790		4.93	11,990
Consumer	4.24	183,223		4.31	182,624
Total recorded investment of noncovered loans		$	2,348,371		$	1,927,191